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How Fiscal Deficit impacts common man?

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"How Fiscal Deficit impacts common man?"

Among the many macroeconomic indicators like fiscal deficit, current account deficit, interest rate, GDP growth rate, inflation, most doesn’t affect the common man in the short run and therefore they are least bothered about them. However, in the long run, all the parameters affect the common man either directly or indirectly. Fiscal deficit is the difference between total revenue and total expenditure of the government. India's fiscal deficit during the April-November period was Rs. 4.13 trillion ($76.2 billion) or 80.4% of the budgeted full fiscal year 2012-13 target.

There is nothing wrong with the government running a deficit per se. The government has to incur deficits to finance its revenue and expenditure mismatches and also to finance investments. The problem arises when the deficit level becomes too high and chronic.

The ill-effects of high deficits are linked to the way they are financed and the use they are put to. The fiscal deficits can be financed through domestic borrowing, foreign borrowing or by printing money. While excessive domestic borrowing can lead to a hardening of interest rates, too much of foreign borrowings can culminate in an external debt crisis. Printing money stokes inflationary pressures.

High government expenditure has a negative impact on savings, which affects growth. The fiscal deficit leads to restricted government spending on infrastructure e.g. power and water shortages, bad roads, inadequate railway network, and grossly underdeveloped ports and so on. This, in turn leads to uncompetitive local industry. Thus it effects the growth of the local domestic industry which is mostly labor intensive.

On the other hand, the deficit restricts subsidies given for agriculture, on which most of our rural economy is based. As the agriculture sector fails, rural purchasing power is directly affected and as a result, there is very little demand for goods and services. This also hits local industry. The government seeks to fill the fund gap with foreign investments – but these come at a price. As borrowers, we are obliged to accept the investor’s interests as paramount, and that is usually at the direct or indirect cost of local industry and trade. Finally, the combined effect of all these three factors causes a lot of local businesses to fail, causing high unemployment. And high unemployment leads to social insecurity.

Typically, high fiscal deficits drive down the real effective exchange rate. Currency depreciation plus high interest rates typically cause high inflation. Moreover, if the fiscal deficit is financed through printing of fresh currency, it leads to the increase in money supply in the economy.

As the supply of goods and services is not increased in accordance with the increase in supply of money, inflation rate will be increased which will directly affect the common people. The combination of a fiscal deficit and pressing need for investment in infrastructure has led to the birth of the ‘public-private-partnership’ concept. In simple words, it is nothing but the government using its powers to allow private companies to build infrastructure and then recover their investment with profits from the general public for the next two or three decades. This kind of public-private partnership’s impact is also greatly felt by the weaker sections of society

Thus, high rate of fiscal deficit affects the common man either directly or indirectly in the long as well as short term. It affects the common man by affecting the economic growth rate, domestic and foreign investment, infrastructure development, inflation, interest rates, unemployment etc.

One of the best ways to reduce the budget deficit as a percentage of GDP is to promote economic growth. If the economy grows, then the government will increase tax revenue, without raising taxes. With economic growth, people pay more VAT, companies pay more corporation tax (tax on profits), and workers pay more income tax. High economic growth is the least painful way to reduce the budget deficit. To reduce fiscal deficits, the government is likely to use a combination of policies. A key factor is the timing of deficit reduction plans. If the country is already in recession, it is much more difficult to reduce the deficit because fiscal consolidation tends to worsen the economic situation leading to lower tax revenues. In some cases, austerity can even be self-defeating.

The best way to reduce the budget deficit is to aim for positive economic growth, but in the long-term evaluate government spending commitments and reduce spending to sustainable levels. Earlier also, when the fiscal deficit was under the prescribed limit of three percent, growth rate was in the vicinity of 8 percent. Thus, while cutting the unwanted expenditure must not be forgotten, stress should be on pushing form higher growth rate.